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Inventories (International Accounting Standard 2) ii.

to exchange financial assets or financial


liabilities with another entity under conditions that
Objective are potentially unfavourable to the entity
(derivative); or
The objective of this Standard is to prescribe the accounting
treatment for inventories. b) a contract that will or may be settled in the entity’s own
equity instruments (derivative
A primary issue in accounting for inventories is the amount
of cost to be recognised as an asset and carried forward Examples of financial liabilities
until the related revenues are recognised.
a) Payables
This Standard provides guidance on the determination of
cost and its subsequent recognition as an expense, b) Lease liabilities
including any write-down to net realisable value.
c) Held for trading liabilities
It also provides guidance on the cost formulas that are used
to assign costs to inventories. d) Derivative liabilities

Scope e) Redeemable preference shares issued

This Standard applies to all inventories, except: f) Returnable deposits

a) financial instruments (see IAS 32 Financial Instruments: An equity instrument is any contract that evidences a
Presentation and IFRS 9 Financial Instruments); and residual interest in the assets of an entity after deducting
all of its liabilities (IAS 32).
b) biological assets related to agricultural activity and
agricultural produce at the point of harvest (see IAS 41 A biological asset is a living animal or plant.
Agriculture).
Agricultural activity is the management by an entity of the
A financial instrument is any contract that gives rise to a biological transformation and harvest of biological assets
financial asset of one entity and a financial liability or equity for sale or for conversion into agricultural produce or into
instrument of another entity (IAS 32). additional biological assets.

(IAS 32) A financial asset is any asset that is: Agricultural produce is the harvested produce of the entity’s
biological assets. (Source: IAS 41)
a) cash;
This Standard does not apply to the measurement (lower
b) an equity instrument of another entity; of cost and net realisable value) of inventories held by:

c) a contractual right: a) producers of agricultural and forest products,


agricultural produce after harvest, and minerals and
i. to receive cash or another financial asset from mineral products, to the extent that they are measured at
another entity; or net realisable value in accordance with well-established
practices in those industries.
ii. to exchange financial assets or financial
liabilities with another entity under conditions that b) commodity (gold, electricity, rice) broker-traders who
are potentially favourable to the entity (derivative, measure their inventories at fair value less costs to sell.
call or put options); or
Note: Broker-traders are those who buy or sell
d) a contract that will or may be settled in the entity’s own commodities for others or on their own account.
equity instruments (derivative).
Definitions
Examples of financial assets
Inventories are assets:
a) Cash and cash equivalents
a) held for sale in the ordinary course of business;
b) Receivables
b) in the process of production for such sale; or
c) Investment in equity or debt instruments
c) in the form of materials or supplies to be consumed in
d) Sinking fund the production process or in the rendering of services.
(IAS 32) A financial liability is any liability that is: Net realisable value is the estimated selling price in the
ordinary course of business less the estimated costs of
a) a contractual obligation:
completion and the estimated costs (to sell) necessary to
i. to deliver cash or another financial asset to make the sale.
another entity; or
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Fair value is the price that would be received to sell an asset Other costs are included in the cost of inventories only to
or paid to transfer a liability in an orderly transaction the extent that they are incurred in bringing the inventories
between market participants at the measurement date. to their present location and condition.
(See IFRS 13 Fair Value Measurement.)
For example, it may be appropriate to include non-
Note: Net realisable value for inventories may not production overheads or the costs of designing products for
equal fair value less costs to sell. specific customers in the cost of inventories.

Measurement of inventories IAS 23 Borrowing Costs identifies limited circumstances


where borrowing costs are included in the cost of
Inventories shall be measured at the lower of cost and net inventories.
realisable value.
Exclusions (cost of inventories)
Cost of inventories
An entity may purchase inventories on deferred settlement
The cost of inventories shall comprise all costs of purchase, terms. When the arrangement effectively contains a
costs of conversion and other costs incurred in bringing the financing element, that element, for example a difference
inventories to their present location and condition between the purchase price for normal credit terms and the
amount paid, is recognised as interest expense over the
Costs of purchase
period of the financing.
The costs of purchase of inventories comprise the purchase
Cost of agricultural produce harvested from biological
price, import duties and other taxes (other than those
assets
subsequently recoverable by the entity from the taxing
authorities, e.g., VAT), and transport, handling and other In accordance with IAS 41 Agriculture inventories
costs directly attributable to the acquisition of finished comprising agricultural produce that an entity has
goods, materials and services. Trade discounts, rebates harvested from its biological assets are measured on initial
and other similar items are deducted in determining the recognition at their fair value less costs to sell at the point
costs of purchase of harvest. This is the cost of the inventories at that date
for application of this Standard.
Import duty is a tax collected on imports and some exports
by a country's customs authorities. Cost formulas
A handling fee is an amount charged to a customer on top The cost of inventories of items that are not ordinarily
of the order subtotal and shipping cost to cover any interchangeable (individually unique) and goods or services
additional expenses related to order fulfillment. produced and segregated for specific projects shall be
assigned by using specific identification of their individual
Handling costs are costs implied on consumer other than
costs.
selling price of product. It can be different for different
industries. For e-commerce it can include warehouse The cost of inventories, other than those dealt with using
storage costs, shipment cost, and packaging cost. For specific identification, shall be assigned by using the first-
Insurance industry it can mean processing and in, first-out (FIFO) or weighted average cost formula. An
administration costs of insurance claims. entity shall use the same cost formula for all inventories
having a similar nature and use to the entity. For
Costs of conversion
inventories with a different nature or use, different cost
The costs of conversion of inventories include costs directly formulas may be justified. For example, inventories used in
related to the units of production, such as direct labour. one operating segment may have a use to the entity
They also include a systematic allocation of fixed and different from the same type of inventories used in another
variable production overheads that are incurred in operating segment.
converting materials into finished goods. Fixed production
A difference in geographical location of inventories (or in
overheads are those indirect costs of production that
the respective tax rules), by itself, is not sufficient to justify
remain relatively constant regardless of the volume of
the use of different cost formulas.
production, such as depreciation and maintenance of
factory buildings, equipment and right-of-use assets used The FIFO formula assumes that the items of inventory that
in the production process, and the cost of factory were purchased or produced first are sold first, and
management and administration. Variable production consequently the items remaining in inventory at the end
overheads are those indirect costs of production that vary of the period are those most recently purchased or
directly, or nearly directly, with the volume of production, produced.
such as indirect materials and indirect labour.
Under the weighted average cost formula, the cost of each
Other costs (included in cost of inventories) item is determined from the weighted average of the cost
of similar items at the beginning of a period and the cost of
similar items purchased or produced during the period. The

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average may be calculated on a periodic basis, or as each amount of inventories recognised as an expense in the
additional shipment is received, depending upon the period in which the reversal occurs.
circumstances of the entity.
Some inventories may be allocated to other asset accounts,
Net realisable value for example, inventory used as a component of self-
constructed property, plant or equipment. Inventories
The cost of inventories may not be recoverable if those allocated to another asset in this way are recognised as an
inventories are damaged, if they have become wholly or expense during the useful life of that asset.
partially obsolete, or if their selling prices have declined.
Disclosure
The cost of inventories may also not be recoverable if the
estimated costs of completion or the estimated costs to be The financial statements shall disclose:
incurred to make the sale have increased.
a) the accounting policies adopted in measuring
The practice of writing inventories down below cost to net inventories, including the cost formula used;
realisable value is consistent with the view that assets
should not be carried in excess of amounts expected to be b) the total carrying amount of inventories and the carrying
realised from their sale or use. amount in classifications appropriate to the entity;

Inventories are usually written down to net realisable value c) the carrying amount of inventories carried at fair value
item by item (damaged). less costs to sell; d) the amount of inventories recognised
as an expense during the period;
In some circumstances, however, it may be appropriate to
group similar or related items (obsolete). This may be the e) the amount of any write-down of inventories recognised
case with items of inventory relating to the same product as an expense in the period;
line that have similar purposes or end uses, are produced
f) the amount of any reversal of any write-down that is
and marketed in the same geographical area, and cannot
recognised as a reduction in the amount of inventories
be practicably evaluated separately from other items in that
recognised as expense in the period;
product line.
g) the circumstances or events that led to the reversal of a
It is not appropriate to write inventories down on the basis
write-down of inventories; and
of a classification of inventory, for example, finished goods,
or all the inventories in a particular operating segment. h) the carrying amount of inventories pledged as security
for liabilities.
A new assessment is made of net realisable value in each
subsequent period. When the circumstances that previously Financial Instruments: Presentation
caused inventories to be written down below cost no longer
exist or when there is clear evidence of an increase in net International Accounting Standard 32
realisable value because of changed economic
Objective
circumstances, the amount of the write-down is reversed
(ie the reversal is limited to the amount of the original The objective of this Standard is to establish principles for
write-down) so that the new carrying amount is the lower presenting financial instruments as liabilities or equity and
of the cost and the revised net realisable value. This occurs, for offsetting financial assets and financial liabilities. It
for example, when an item of inventory that is carried at applies to the classification of financial instruments, from
net realisable value, because its selling price has declined, the perspective of the issuer, into financial assets, financial
is still on hand in a subsequent period and its selling price liabilities and equity instruments; the classification of
has increased. related interest, dividends, losses and gains; and the
circumstances in which financial assets and financial
Recognition as an expense
liabilities should be offset. (IAS 32 par. 2)
When inventories are sold, the carrying amount of those
The principles in this Standard complement the principles
inventories shall be recognised as an expense in the period
for recognising and measuring financial assets and financial
in which the related revenue is recognised.
liabilities in IFRS 9 Financial Instruments, and for disclosing
The amount of any write-down of inventories to net information about them in IFRS 7 Financial Instruments:
realisable value and all losses of inventories shall be Disclosures. (IAS 32 par. 3)
recognised as an expense (“loss on inventory writedown”,
A financial instrument is any contract that gives rise to a
as part of “other expenses”) in the period the write-down
financial asset of one entity and a financial liability or equity
or loss occurs.
instrument of another entity. (IAS 32 par. 11)
The amount of any reversal of any write-down of
Examples of financial instrument
inventories, arising from an increase in net realisable value,
shall be recognised as a reduction in (cost of sales) the 1. Cash in the form of notes and coins

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2. Cash in the form of checks Liabilities or assets that are not contractual (such as income
taxes that are created as a result of statutory requirements
3. Cash in bank imposed by governments) are not financial liabilities or
financial assets. Accounting for income taxes is dealt with
4. Trade accounts
in IAS 12. Similarly, constructive obligations, as defined in
5. Note and loan IAS 37 Provisions, Contingent Liabilities and Contingent
Assets, do not arise from contracts and are not financial
6. Debt security liabilities. (IAS 32 par. AG12)

7. Equity security A constructive obligation is an obligation that derives from


an entity’s actions where: (a) by an established pattern of
Financial asset
past practice, published policies or a sufficiently specific
A financial asset is any asset that is: current statement, the entity has indicated to other parties
that it will accept certain responsibilities; and (b) as a
1. cash; result, the entity has created a valid expectation on the part
of those other parties that it will discharge those
2. an equity instrument of another entity; responsibilities. (IAS 37 par. 10)
3. a contractual right: a. to receive cash or another financial Equity instrument
asset from another entity; or b. to exchange financial
assets or financial liabilities with another entity under An equity instrument is any contract that evidences a
conditions that are potentially favourable to the entity residual interest in the assets of an entity after deducting
(derivatives, e.g., call or put options); or all of its liabilities. (IAS 32 par. 11)

4. a contract that will or may be settled in the entity’s own Equity instruments include ordinary share capital,
equity instruments ... (derivatives). (IAS 32 par. 11) preference share capital, and warrants or option.

Financial liability Share warrants

A financial liability is any liability that is: In finance, a warrant is a security that entitles the holder
to buy the underlying stock of the issuing company at a
1. a contractual obligation: fixed price called exercise price until the expiry date.
Warrants and options are similar in that the two contractual
a. to deliver cash or another financial asset to
financial instruments allow the holder special rights to buy
another entity; or b. to exchange financial assets
securities. Wikipedia
or financial liabilities with another entity under
conditions that are potentially unfavourable to the Share option
entity (derivatives); or
a benefit in the form of an option given by a company to an
2. a contract that will or may be settled in the entity’s own employee to buy a share in the company at a discount or
equity instruments … (derivatives). (IAS 32 par. 11) at a stated fixed price.
Nonfinancial assets and liabilities Liabilities and equity
Physical assets (such as inventories, property, plant and The issuer of a financial instrument shall classify the
equipment), right-of-use assets and intangible assets (such instrument, or its component parts, on initial recognition as
as patents and trademarks) are not financial assets. Control a financial liability, a financial asset or an equity instrument
of such physical assets, right-of-use assets and intangible in accordance with the substance of the contractual
assets creates an opportunity to generate an inflow of cash arrangement and the definitions of a financial liability, a
or another financial asset, but it does not give rise to a financial asset and an equity instrument. (IAS 32 par. 15)
present right to receive cash or another financial asset.
(IAS 32 par. AG10) To determine whether a financial instrument is an equity
instrument rather than a financial liability, the instrument
Assets (such as prepaid expenses) for which the future is an equity instrument if the instrument includes no
economic benefit is the receipt of goods or services, rather contractual obligation to deliver cash or another financial
than the right to receive cash or another financial asset, are asset ... (IAS 32 par. 16)
not financial assets. Similarly, items such as deferred
revenue and most warranty obligations are not financial Redeemable preference share
liabilities because the outflow of economic benefits
associated with them is the delivery of goods and services The substance of a financial instrument, rather than its
rather than a contractual obligation to pay cash or another legal form, governs its classification in the entity’s
financial asset. (IAS 32 par. AG11) statement of financial position. Substance and legal form
are commonly consistent, but not always. Some financial
instruments take the legal form of equity but are liabilities

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in substance and others may combine features associated IFRS 9 deals with the measurement of financial assets and
with equity instruments and features associated with financial liabilities. Equity instruments are instruments that
financial liabilities. evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when the initial
For example: a preference share that provides for carrying amount of a compound financial instrument is
mandatory redemption by the issuer for a fixed or allocated to its equity and liability components, the equity
determinable amount at a fixed or determinable future component is assigned the residual amount after deducting
date, or gives the holder the right to require the issuer to from the fair value of the instrument as a whole the amount
redeem the instrument at or after a particular date for a separately determined for the liability component. The sum
fixed or determinable amount, is a financial liability. (IAS of the carrying amounts assigned to the liability and equity
32 par. 18) components on initial recognition is always equal to the fair
value that would be ascribed to the instrument as a whole.
Interest, dividends, losses and gains
No gain or loss arises from initially recognising the
Interest, dividends (e.g., paid to holders), losses and gains components of the instrument separately. (IAS 32 par. 31)
relating to a financial instrument or a component that is a
Financial Instruments IFRS 9
financial liability (e.g., mandatorily redeemable preference
shares) shall be recognised as income or expense (e.g., Objective
interest expense) in profit or loss. Distributions to holders
of an equity instrument shall be recognised by the entity The objective of this Standard is to establish principles for
directly in equity. Transaction costs of an equity transaction the financial reporting of financial assets and financial
shall be accounted for as a deduction from equity. (IAS 32 liabilities that will present relevant and useful information
par. 35) to users of financial statements for their assessment of the
amounts, timing and uncertainty of an entity’s future cash
Compound financial instruments flows. (IFRS 9 par. 1.1)
The issuer of a non-derivative financial instrument shall Classification of financial assets
evaluate the terms of the financial instrument to determine
whether it contains both a liability and an equity Unless paragraph 4.1.5 applies, an entity shall classify
component. Such components shall be classified separately financial assets as:
as financial liabilities, financial assets or equity
instruments. (IAS 32 par. 28) a. subsequently measured at amortised cost,

Paragraph 28 applies only to issuers of non-derivative b. subsequently measured at fair value through other
compound financial instruments. Paragraph 28 does not comprehensive income; or
deal with compound financial instruments from the
c. subsequently measured at fair value through profit or
perspective of holders. IFRS 9 deals with the classification
loss on the basis of both:
and measurement of financial assets that are compound
financial instruments from the holder’s perspective. (IAS 32 a. the entity’s business model for managing the
par. AG30) financial assets and

An entity recognises separately the components of a b. the contractual cash flow characteristics of the
financial instrument that (a) creates a financial liability of financial asset. (IFRS 9 par. 4.1.1)
the entity and (b) grants an option to the holder of the
instrument to convert it into an equity instrument of the Option to designate a financial asset at fair value through
entity. For example, a bond or similar instrument profit or loss
convertible by the holder into a fixed number of ordinary
An entity may, at initial recognition, irrevocably designate
shares of the entity (“convertible bonds”) is a compound
a financial asset as measured at fair value through profit or
financial instrument. From the perspective of the entity,
loss if doing so eliminates or significantly reduces a
such an instrument comprises two components: a financial
measurement or recognition inconsistency (sometimes
liability (a contractual arrangement to deliver cash or
referred to as an ‘accounting mismatch’) that would
another financial asset) and an equity instrument (a call
otherwise arise from measuring assets or liabilities or
option granting the holder the right, for a specified period
recognising the gains and losses on them on different
of time, to convert it into a fixed number of ordinary shares
bases. (IFRS 9 par. 4.1.5)
of the entity). The economic effect of issuing such an
instrument is substantially the same as issuing A financial asset shall be measured at amortised cost if both
simultaneously a debt instrument with an early settlement of the following conditions are met:
provision and warrants to purchase ordinary shares (e.g.,
“bonds issued with share warrants”), or issuing a debt a. the financial asset is held within a business model whose
instrument with detachable share purchase warrants. objective is to hold financial assets in order to collect
Accordingly, in all cases, the entity presents the liability and contractual cash flows and
equity components separately in its statement of financial
position. (IAS 32 par. 29)
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b. the contractual terms of the financial asset give rise on b. at fair value through other comprehensive income (fair
specified dates to cash flows that are solely payments of value plus direct transaction costs)
principal and interest on the principal amount outstanding.
c. at fair value through profit or loss (fair value, direct
A financial asset shall be measured at fair value through transaction costs are expensed outright)
other comprehensive income if both of the following
conditions are met: Despite the requirement in paragraph 5.1.1, at initial
recognition, an entity shall measure trade receivables at
a. the financial asset is held within a business model whose their transaction price (as defined in IFRS 15) if the trade
objective is achieved by both collecting contractual cash receivables do not contain a significant financing
flows and selling financial assets and component in accordance with IFRS 15. (IFRS 9 par. 5.1.3)

b. the contractual terms of the financial asset give rise on Subsequent measurement
specified dates to cash flows that are solely payments of
principal and interest on the principal amount outstanding. After initial recognition, an entity shall measure a financial
asset at:
A financial asset shall be measured at fair value through
profit or loss unless it is measured at amortised cost or at a. amortised cost;
fair value through other comprehensive income. However
b. fair value through other comprehensive income; or
an entity may make an irrevocable election at initial
recognition for particular investments in equity instruments c. fair value through profit or loss. (IFRS 9 par. 5.2.1)
that would otherwise be measured at fair value through
profit or loss to present subsequent changes in fair value in Gains and losses
other comprehensive income.
A gain or loss on a financial asset or financial liability that
At initial recognition, an entity may make an irrevocable is measured at fair value shall be recognised in profit or
election to present in other comprehensive income loss unless:
subsequent changes in the fair value of an investment in
a. ...
an equity instrument within the scope of this Standard that
is neither held for trading nor contingent consideration b. it is an investment in an equity instrument and the entity
recognised by an acquirer in a business combination to has elected to present gains and losses on that investment
which IFRS 3 applies. (IFRS 9 par. 5.7.5) in other comprehensive income;
Financial assets at fair value through profit or loss c. ...
1. Financial assets held for trading (or “trading securities”) d. it is a financial asset measured at fair value through
other comprehensive income and the entity is required to
2. Quoted equity instruments not measured at fair value
recognise some changes in fair value in other
through other comprehensive income.
comprehensive income. (IFRS 9 par. 5.7.1)
3. Debt investments that are irrevocably designated on
Account titles
initial recognition as at fair value through profit or loss.
1. Financial asset - FVPL
4. Debt investments that do not satisfy the requirements
for measurement at amortized cost and at fair value 2. Trading securities
through other comprehensive income.
3. Commission expense (an example of direct transaction
Measurement cost)
Initial measurement 4. Unrealized gain/loss - TS
Except for trade receivables within the scope of paragraph 5. Gain/loss on sale of trading securities
5.1.3, at initial recognition, an entity shall measure a
financial asset or financial liability at its fair value plus or 6. Financial asset - FVOCI
minus, in the case of a financial asset or financial liability
not at fair value through profit or loss, (fair value plus) 7. Unrealized gain/loss - OCI
transaction costs that are directly attributable to the
8. Retained earnings (both “Financial asset - FVOCI” and
acquisition or issue of the financial asset or financial
“Unrealized gain/loss - OCI” are derecognized)
liability. (IFRS 9 par. 5.1.1)

Financial assets subsequently measured:

a. at amortised cost (fair value plus direct transaction


costs)